Improving access to capital markets finance for SMEs

There has been a recent focus, both at EU level and in the UK, on the need to improve access to capital markets finance for small and medium-sized enterprises. There are differing views on how best to achieve this: some advocate reduced, or more proportionate, standards of disclosure for SMEs, while others focus on improving the quality of the information disclosed as the key to increasing investor appetite. The two approaches could be seen as being at odds, given the former promotes greater flexibility and simpler reporting, while the latter arguably means a greater reporting burden. Either way, AIM companies, and their investors and advisers, should take note: while there is a prospect of reduced regulation at EU level, recent UK guidance emphasising the need for better quality disclosure may have a more immediate impact.

Capital Markets Union: unlocking investment through simpler and standardised reporting requirements

At the Capital Markets Union (CMU) conference in Brussels on 8 June 2015, the EU Commissioner for Financial Services, Financial Stability and Capital Markets Union made it clear that a top priority emerging from the Commission’s CMU consultation is improving Europe’s “funding escalator”, i.e. building a financial system that is better able to meet the financing needs of all businesses at different stages in their development. Part of this involves making it easier for SMEs to raise capital by issuing debt or equity on public markets, rather than having them rely, as they have done historically, on bank finance. The Commission’s green paper, published in February, suggests ways to unlock investment for smaller entities, including through simpler reporting requirements, a single market for capital and a single rulebook for financial services.

Simplified prospectus requirements to improve access to finance

On the same theme, the European Commission is consulting on whether there should be a simplified prospectus regime for companies admitted to trading on SME growth markets, in order to facilitate their access to capital market financing. The Quoted Companies Alliance, among others, believes that simplifying the prospectus requirements and making the process of producing a prospectus less complex would improve access to finance for SMEs, without sacrificing a high level of investor protection if prospectus requirements were made more relevant and appropriate.

Annual reports: facilitating investment through higher-quality reporting

From an apparently different perspective, in the UK the Financial Reporting Council (FRC), in its June discussion paper, “Improving the Quality of Reporting by Small Listed and AIM Quoted Companies“, argues that making improvements to the quality of reporting would provide better and more relevant information to investors and potentially open up greater access to capital for some companies; despite companies’ perceptions, annual reports are important to investors and an investor is more likely to invest if the annual report conveys a clear message of the company’s business model and prospects.

The FRC proposes to provide reminders to boards on current issues, areas of investor focus and common errors in annual reports, work with accountancy and audit bodies to develop more focused training to finance staff, and develop practical guidance for audit committees and boards on evaluating the adequacy of financial reporting functions and processes.

Meanwhile, the AIM Regulation team of the London Stock Exchange, in the first issue of its new publication, Inside AIM, has stressed the need for financial policies and procures to be robust. Under AIM Rule 31, AIM companies are required to have in place sufficient systems, procedures and controls to enable them to comply with the AIM Rules. Consideration of these matters by the company’s nominated adviser involves the review of financial policies and procedures documentation. This should be approached in a meaningful way, including assessing whether those policies are capable of working in practice, taking into account the Nomad’s knowledge of the company and its management.

EU-wide accounting standards and UK GAAP as an alternative to IFRS

As part of its investigation leading to its June discussion paper, the FRC explored whether AIM companies should be allowed to report under UK GAAP. The overwhelming response was that IFRS (which is perceived by some as being unnecessarily complex) should remain the reporting framework for all listed companies, although the volume of disclosures might be reviewed. The FRC is however going to consider whether the Capital Markets Union provides an opportunity to develop a differentiated disclosure framework for smaller quoted companies, building on the IFRS-based approach adopted in UK GAAP.

Simpler, but better quality, disclosures?

While the FRC’s proposals for financial reporting and the AIM team’s suggestion that financial policies need to be more carefully reviewed could be seen as pointing towards a greater burden for SMEs and their advisers, perhaps these developments are in fact complementary with the European drive towards simpler reporting requirements. If we are going to have more proportionate and flexible reporting standards for smaller quoted companies, arguably it is even more important, from the perspective of attracting potential investors, for what is disclosed to be high quality, accurate and meaningful.

With the Commission’s Capital Markets Union Action Plan due out in September, the Commission deciding in the next few months how to amend the Prospectus Directive and the FRC holding an open meeting in July to discuss its findings so far on financial reporting, SMEs, and their investors and advisers, will be watching with interest.